What is Earnings Before Interest & Tax - EBIT
Earnings before interest and taxes is an indicator of a company's profitability. One can calculate it as revenue minus expenses, excluding tax and interest. EBIT is calculated as:
EBIT = Revenue - Operating Expenses
EBIT = Net Income + Interest + Taxes
EBIT is also referred to as operating earnings, operating profit, and profit before interest and taxes.
EBIT (Earnings Before Interest and Taxes)
BREAKING DOWN Earnings Before Interest & Tax - EBIT
Earnings before and taxes measures the profit a company generates from its operations, making it synonymous with operating profit. By ignoring tax and interest expenses, it focuses solely on a company's ability to generate earnings from operations, ignoring variables such as the tax burden and capital structure.
This focus makes EBIT an especially useful metric for certain applications. For example, if an investor is thinking of buying a firm out, the existing capital structure is less important than the company's earning potential. Similarly, if an investor is comparing companies in an industry that operate in different tax environments and have different strategies for financing themselves, tax and interest expenses would distract from the core question: How effectively do these companies generate profits from their operations?
There are different ways to go about calculating EBIT, which is not a GAAP metric and therefore not usually included in financial statements. Always begin with total revenue or total sales and subtract operating expenses, including the cost of goods sold. You may take out one-time or extraordinary items, such as the revenue from the sale of an asset or the cost of a lawsuit, as these do not relate to the business' core operations, but these may also be included. If a company has non-operating income, such as income from investments, this may be—but does not have to be—included; in that case, EBIT is distinct from operating income, which, as the name implies, does not include non-operating income.
Often, companies include interest income in EBIT, but some may exclude it depending on its source. If the company extends credit to its customers as an integral part of its business, then this interest income is a component of operating income and a company will always include it. If, on the other hand, the interest income derives from bond investments, or charging fees to customers that pay their bills late, it may be excluded. As with the other adjustments mentioned, this one is up to the investor's discretion, and should be applied consistently to all companies being compared.
In the simplest terms, one can calculate EBIT by taking the net income figure from the income statement and adding the income tax expense and interest expense back in. Put a different way, operating expenses are subtracted from total revenue. As an example, we'll use Procter & Gamble Co's income statement from the year ending June 30, 2016 (all figures in millions of USD):
|Cost of products sold||32,909|
|Selling, general and administrative expense||18,949|
|Other non-operating income, net||325|
|Earnings from continuing operations before income taxes||13,369|
|Income taxes on continuing operations||3,342|
|Net earnings (loss) from discontinued operations||577|
|Less: net earnings attributable to non-controlling interests||96|
|Net earnings attributable to Procter & Gamble||10,508|
To calculate EBIT, we subtract the cost of goods sold and the selling, general and administrative expense from the net sales. We then add non-operating income and interest income to get an EBIT of:
EBIT = Net Sales - COGS - SGA Expense + Non-Operating Income + Interest Income
EBIT = $65,299 - $32,909 - $18,949 + $325 + $182 = $13,948
For the fiscal year ended 2015, P&G had a Venezuelan charge. Whether to include the Venezuela charge raises questions. As mentioned above, a company can exclude one-time expenses. In this case, a note in the 2015 earnings release explained that the company was continuing to operate in the country though subsidiaries. Due to capital controls in effect at the time, however, P&G was taking a one-time hit to remove Venezuelan assets and liabilities from its balance sheet.
Similarly, one can make an argument for excluding interest income and other non-operating income from the equation. These considerations are to some extent subjective, but one should apply consistent criteria to all companies being compared.
Another way to calculate P&G's fiscal 2015 EBIT is to work from the bottom up, beginning with the net earnings. We ignore non-controlling interests, as we're only concerned with the company's operations, and subtract the net earnings from discontinued operations for much the same reason. We then add income taxes and interest expense back in to obtain the same EBIT we did via the top-down method:
EBIT = Net Earnings - Net Earnings from Discontinued Operations + Income Taxes + Interest Expense
Therefore, EBIT = $10,604 - $577 + $3,342 + $579 = $13,948